Executive Pay Increasingly Linked To Climate Goals But Often Ineffective

21 November 2024

Australian companies are increasingly linking executive remuneration to climate transition efforts. However many attempts to do so are currently ineffective because they are not linked to a climate transition strategy with clear and measurable results, according to a new study from the Investor Group on Climate Change (IGCC) and climate and nature investment and advisory firm Pollination.

Incentivising Climate Action with Executive Remuneration in Australia surveys and benchmarks 14 high-emitting ASX-listed companies against a set of Guiding Principles that represent best practice in effectively linking executive pay to climate performance.

“In recent years we have seen large increases in Australian companies wanting to link their leaders’ pay with climate performance, as they respond to market pressures to show progress on transition,” Zoe Witton, Managing Director at Pollination said.

“Australia is increasingly on par with other leading global economies in establishing such links but while action is promising, there’s a lot of work to be done to make it more effective.”

The report finds that while companies are attempting to link pay to transition plans, this strategy has been largely ineffective at driving emissions reduction.

While companies are increasingly linking pay to climate transition plans, the selected metrics are failing to drive strong climate outcomes, primarily due to challenges in aligning long-term commitments with meaningful short-term action.

In cases such as mining or industrial production, short-term growth targets can be explicitly in opposition to climate targets with longer-term economic benefits. Measurable success in reaching climate targets may also not be determined for decades.

The findings draw on extensive interviews with investors, proxy advisors, board members, and senior executives to understand the challenges and opportunities investors face when engaging on remuneration issues with their portfolio companies.

Investors See Climate-related Targets in Executive REM as a Signal of Intent

The report finds investors have a growing appetite for companies integrating climate-related targets into executive remuneration, which is helping to drive corporate enthusiasm for the practice. According to the Australian Council of Superannuation Investors (ACSI), 54 per cent of ASX200 companies make such linkages in 2024, up from ten per cent in 2020.

Increased regulatory and disclosure obligations as well as reputational and social licence concerns are also common factors driving the growing practice.

Linking climate-related metrics to executive pay is an important signal of intent, the report argues, allowing investors to make decisions based on how aligned a company’s leadership is to climate performance — encouraging company targets to be met as well as driving further ambition.

Despite this, the inclusion of climate targets in executive remuneration can't operate in a vacuum and must be supported by realistic strategy.

“If you have long term targets but no clearly articulated and implementable transition strategy which breaks down action into shorter term chunks and checkpoints, tying executive remuneration to climate goals is unlikely to be effective,” said Rebecca Mikula-Wright CEO of IGCC.

Guiding Principles for Effective Climate-Linked Executive Remuneration

The report provides a set of Guiding Principles for climate-linked remuneration for investors and companies to follow. These guiding principles are analysed against the remuneration practices of 14 high-emitting ASX-listed companies, finding that although adoption of climate-related incentives is common, alignment with the Guiding Principles is low. Only ten per cent or fewer of companies surveyed were deploying an approach that was highly aligned.

“We want to see companies setting a credible climate strategy before incentivising action,” said Mikula-Wright. “The incentives and strategy must be aligned.”

The results suggest that current executive incentives are often not fully aligned with climate goals and the weighting of climate-related incentives may not reflect the materiality of climate risks and opportunities.

“Investors want to see companies progress from climate commitments to effective activity to decarbonise the economy, reduce portfolio risk, and increase long-term returns,” Mikula-Wright said. ‘’If done correctly, incentivising corporate leaders should help companies meet their own targets and increase the likelihood of successful economy-wide transition.”

As well as providing best practice principles for companies wanting to link remuneration with climate performance, the report provides an engagement framework for investors to evaluate company performance when it comes to such linkages. It argues providing investors with such guidance can incentivise greater strategic alignment when it comes to executive pay and climate performance, encouraging companies to prioritise long term sustainability and prosperity over competing short-term gains.

Additional Quotes

Rebecca Mikula-Wright, CEO of the Investor Group on Climate Change:

“Linking executive pay to climate targets creates a powerful lever for companies to prioritise their climate goals and address decarbonisation challenges. However, executive incentives are often not fully aligned with climate goals and the weighting of climate-related incentives may not reflect the materiality of climate risks and opportunities. This report equips investors with the tools to ensure companies are implementing remuneration structures that drive credible, measurable steps toward emissions reduction and climate resilience.”

Zoe Witton, Managing Director of Pollination:

“With a new Government in the United States we can expect global corporates to do even more of the heavy lifting when it comes to the decarbonisation that needs to happen if we are to transition economies towards net zero. Linking executive pay with climate performance is a growing practice which has the potential to improve the governance of transition across markets. But the fundamentals of corporate transition efforts remain unchanged. If you don’t have clear strategy in place to guide short, medium and long-term actions executive remuneration is unlikely to be an effective mechanism to support an orderly transition.”

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